SPECIAL OFFER: - Limited Time Only!
(The ad below will not display on your printed page)
Are you saving enough for retirement? Is your money invested wisely? If you're like most people, the answers are probably no and no. But to have the kind of comfortable retirement you want -- with the same standard of living you now enjoy along with travel and visits to the grandkids built in -- you have to set aside a lot of money during your working years and have something better than a pin-the-tail-on-the-donkey strategy for making it grow. We know: Socking a hefty chunk of your salary into a 401(k) or IRA isn't easy, especially in this economy. But make no mistake, what you put away now -- and how carefully you manage it -- will determine whether you can lead the good life after your working years are done. These nine simple steps can help you get your retirement planning on track.
1. Max out your retirement contributions.
After the stock market dive of 2008, it's clear that throwing 4 or 5 percent of your annual income into a 401(k) or IRA and hoping for big annual returns isn't going to cut it. "You're much better off contributing more and investing it less riskily," says Dallas Salisbury, president and CEO of the Employee Benefit Research Institute, a nonprofit agency in Washington, D.C.
Simple Rule of Thumb: Try to contribute 15 percent of your take-home pay. That's a ton of money to pull out of your monthly budget, but remember that 401(k) contributions are pretax and those to your IRA are tax-deductible, so every dollar you put away would really only cost you about 75 cents. Every bit counts. If you can up your contribution level only 1 percentage point this year -- say, from 9 to 10 percent -- do it. Try to up it to 11 percent next year and so on. Just be aware that the 15 percent benchmark assumes you started contributing in your 20s. "You need to add 5 percent for every decade you've delayed to make up for lost time," says Salisbury. So if you didn't start contributing until you were in your 30s, your goal should be to contribute 20 percent of your salary; if you waited until you were in your 40s, make it 25 percent.
2. Spread your money around.
To safeguard against market downturns and to turn the best long-term profit, you need to diversify your portfolio. You want investments in U.S. and international companies, small start-ups and big established corporations, bonds and Treasuries, and all the various sectors of the economy, says Thomas Collimore, director of investor education for the Chartered Financial Analyst Institute. Buy mutual funds and forget about buying individual stocks.
Simple Rule of Thumb: Let the professionals do the work. In a company-sponsored 401(k) plan, the core menu of mutual fund options is designed to provide a diverse array of investments. For an IRA or any account you manage yourself, call an independent financial planner for help creating a smart mix.
3. Pick the right amount of risk.
The big stock market gains of the late '90s enticed many of us into aggressive portfolios. Why mess with slow and steady bond and Treasury fund returns when stock funds could see 6 to 10 percent annual growth? However, as we all learned, those returns can quickly undo themselves. If you're 30 and your career is ahead of you, you can wait for the market to rebound. But if a downturn happens when you're in your 50s or 60s it can devastate an aggressively invested nest egg. So every few years, make your portfolio more conservative.
Simple Rule of Thumb: Keep the percentage of your nest egg in bonds roughly equal to your age. So at age 30, put 30 percent of your account in bond funds and 70 in stock funds; when you're 55, make the split 55/45.
4. Set up automatic rebalancing.
You've maxed out your salary contributions and chosen a good mix of mutual funds, so now you can sit back and let the money grow, right? Wrong. You need to keep your portfolio balanced. Some funds in your portfolio will outperform or underperform others. As a result, the percentages invested in each will no longer match the allocation you set up, putting you at greater risk for a loss or for missing out on a gain. So at least annually you need to log on and rebalance your money to your originally intended proportions.
Simple Rule of Thumb: Ask whether your retirement account offers an automatic rebalancing program, says Salisbury. This free and widely available computerized service reallocates your money to match your chosen allocations. Select at least annual rebalancing -- or as often as quarterly.
5. Play it safe with target funds.
One alternative to allocating and rebalancing is to forgo mutual funds and choose a single target fund. Offered by many 401(k) plans and IRAs, target funds don't invest in stocks, bonds, and Treasuries; instead they buy other mutual funds and are designed with a particular time horizon in mind. If you're 50 and expect to work 14 more years, for instance, you can get a target 2025 fund; if you're 40 you'd get a target 2035 fund. They automatically rebalance themselves to become more conservative over time based on target dates. But be aware that some target funds use fairly aggressive strategies. During the worst of the 2008 stock plunge some 2010 funds -- which should have been very conservative given the closeness of their target date -- were down 40 percent.
Simple Rule of Thumb: If your mutual fund company offers both aggressive and conservative target funds, choose the latter, says Salisbury. Otherwise, pick one designed to mature earlier.
6. Judge funds by fees, not past results.
Most investment brochures warn that "past performance does not guarantee future results." So ignore the past performance numbers and focus on the one stat that is sure to impact your returns: cost. Funds with low expenses tend to have the best performance over time, according to Christine Benz, director of personal finance at the investment research company Morningstar. Choose no-load funds, which don't charge fees for the right to buy, sell, or hold them, as some mutual funds do. They do have management costs, however, and when you're comparing similar funds look at their fees, which are listed in the plan paperwork as a percentage of assets. (One international growth fund might charge 2 percent while another wants 0.5 percent.) The lowest-fee funds, and probably the best bet for most people, are index funds, which simply mirror a stock or bond index, such as the S&P 500, and thus have no high-priced management team, bringing annual costs as low as 0.2 percent or less. They outperform most managed funds anyway.
Simple Rule of Thumb: Choose funds on Morningstar that have a top track record. You can see a free rating (from one to five stars) of any mutual fund based on its fees, strategies, potential returns, and risks at morningstar.com.
7. Prepay the mortgage.
Paying off your mortgage, or any debt, as fast as possible is one of the best ways to plan for retirement, says Salisbury. After all, if you wipe out your mortgage before you retire, you eliminate your largest monthly expense. And with savings account interest rates at historic lows, you'll get a much better return by putting extra cash toward the mortgage anyway.
Simple Rule of Thumb: Adding about $100 to each monthly mortgage payment will knock five years off a 30-year $200,000 loan -- and save you almost $50,000 in interest, too.
8. Add a Roth if you can.
Thanks to ballooning national debt, many experts predict significantly higher tax rates in coming decades. That makes Roth 401(k) and IRA benefits better than ever, says Salisbury. With Roths you trade a tax benefit now for one when you retire: Rather than writing off annual contributions, as you do with a standard IRA, or contributing pretax dollars, as with a standard 401(k), you get no tax advantage in the current year. But when you make withdrawals after retirement you'll pay no taxes. Since tax rates may be more onerous then, that could be a better deal.
Simple Rule of Thumb: Put as much of your retirement contribution as possible into a Roth. Many 401(k) plans now allow Roth contributions; if your adjusted gross income is less than $120,000, or $167,000 for a married couple, you can put up to $5,000 (or $6,000 if you're over 50 years old) into a Roth IRA.
9. Buy long-term care insurance.
The biggest financial risk we all face as we age is the potential need for long-term care. It might be a visiting nurse, an assisted-living facility, or a nursing home -- all of which are extremely expensive. True, you can get Medicaid to pick up the tab, but only for limited care options and often after you have to liquidate and turn over all your assets. Alternatively, long-term-care insurance can defray the cost, giving you choices in the care you receive and protecting your assets, says Kim Holland, insurance commissioner for the state of Oklahoma. Look for a policy that offers inflation adjustment so that your coverage amount will go up as medical costs escalate, and confirm that the issuer will be around to pay by checking its financial strength with the ratings agencies S&P (standardandpoors.com), Moody's (moodys.com), A.M. Best (ambest.com), and Fitch (fitchratings.com).
Simple Rule of Thumb: If you can afford to, buy a policy while you're in your 50s. It can cost a whopping $150 to $400 per month, but if you wait until your 60s, you'll pay about $200 to $600 a month -- and if you get sick in the interim you may be denied a policy.
Originally published in Ladies' Home Journal, December 2010/November 2011.